Redwood’s primary business is investing in the absolute eye of the storm: single family residential real estate loans. Redwood’s current portfolio totals about $133 billion in loans to over 300,000 miscreants whose sole redeeming quality in 2005 and 2006 was their ability to sign where indicated. RWT also invests in a variety of other residential and commercial real estate loans and securities.
Like AIG, RWT has also rented out its balance sheet in order to credit-enhance single family RMBS, although unlike AIG they appear to have actually kept track of their potential liabilities under these arrangements.
On March 16th, JP Morgan initiated coverage of RWT with an Overwieght rating and an $18 price target. The reason? Debt maturities, or more accurately the lack of them. After raising equity in January, Redwood had 65% of its equity in cash with its only recourse debt maturing 28 years from now. This is the theme of the moment, if not the millenium.
Compare RWT to MAC, which is struggling to refinance 2010 debt maturities, or GGP, which is technically insolvent due to near-term maturities. The market has been unkind to both of the latter, while RWT has held up well, in spite of the January dilution and its focus on one of the most unhealthy sectors of the mortgage market.
The lack of leverage will also allow Redwood to weather future volatility by avoiding mark-to-market-related margin calls. “As RWT does not lever its purchases with short-term recourse financing, the company avoids margin call risk brought on by declines in mark-to-market asset values,” JP Morgan said in its report.
The cash raised in January has also allowed Redwood to be a true opportunistic player. According to JP Morgan, RWT recently purchased prime credit enhanced AAA-rated mortgage-backed securities at about 65 cents on the dollar. RWT projects returns of 10-18% on those assets, which were underwritten for further home price declines and worsening consumer credit.
RWT intends to continue these mortgage investments, targeting 10-20% unlevered returns. However, the current market turmoil has kept RWT from betting the bank, giving the Company plenty of dry powder going forward.
“We believe Redwood’s dedicated team of mortgage credit professionals is well positioned with a clean balance sheet to take advantage of the ongoing dislocation in the housing market, and the lack of leverage will allow the company to weather future volatility by avoiding mark-to-market-related liquidity risks,” JPMorgan said.